Monday, October 22, 2012

The Chinese Dilemma

From the Financial Times:

First, the dilemma facing China: that moving to consumption could raise the cost of capital for investment at a time when investment is needed for urbanisation and for dealing with demographic change. Why? Higher consumption means households will have to save less. But household savings in China have provided a captive and cheap source of capital, thanks to deposit rates from commercial banks that hover around zero in real terms. Reducing those savings will mean a higher cost of capital.
Second, the dilemma facing emerging market economies: that there is probably a trade-off between shoring up growth in the short term and pursuing the reforms that will bolster longer-term growth. Most emerging market economies have room for monetary easing, and most have fiscal legroom too. However, using broad-based easing tends to (temporarily) reinvigorate the existing model. In 2009, China pushed investment higher, India raised its consumption and commodity exporters became more commodity-orientated – all of which made these economies even more unbalanced. Emerging markets need to resist that impulse.

Third, the dilemma for the emerging market growth model: that external demand is not available, while adopting a domestically demand-driven strategy also has risks, as explained in a note by Harvard’s Dani Rodrik. The manufacturing sector in an emerging market economy, Prof Rodrik shows, is the one part that can converge towards its counterpart in the advanced economies. If export-orientated growth is a thing of the past, then the manufacturing sector is unlikely to grow rapidly, putting the catch-up with advanced economies at risk. Emerging markets are then caught between the uncertainty surrounding external demand and risk to manufacturing convergence from domestic demand-led growth.